If investment mutual fund managers were truly skilled at beating the market, then you would expect mutual fund manager performance prowess to persist over time.

Unfortunately, the evidence indicates that superior past professional performance among mutual fund managers tends not to persist. Past superior mutual fund performance is simply not a predictor of future superior mutual fund performance.

Over time, securities prices change, because risk and return expectations change. Older concerns are resolved and new risks arise. As time and events roll forward, new information becomes available, that influences whether investors find a particular security to be more or less attractive. A vast array of financial, competitive, managerial, political, natural, technological, and numerous other factors will influence the evolution of securities market values.

Just because the price of an investment security changes over time does not mean that investors were right or wrong before when they purchased or sold short a security. It simply means that the future did not unfold according to the projected risk-adjusted market consensus that existed when the security was acquired. (See: Distinguishing between true investment skill and luck)

Securities prices are bound to change and there will be supposed “winners” and “losers.” Winners will take credit and boast of their supposed wisdom, while losers will tend to keep quiet and lick their wounds. The problem is that rarely do either winners or losers actually win or lose because they made a precise and accurate prediction of future events that actually did occur. (See: Chance creates the illusion that investors can beat the stock market)

When the investment portfolio performance of money managers is measured on a risk-adjusted basis, winners are judged to have captured “positive ‘alpha’ ” (a statistical performance comparison to a benchmark) and losers will have “negative ‘alpha.’ ” Are these positive and negative deviations from the average the result of skill, or are they just due to random price fluctuations?

If mutual fund managers were truly skilled at beating the market, then one would expect their excess investment returns performance to persist over time.

Most individual investors have long-term financial objectives and hope that money managers who are entrusted with their assets will deliver relatively high future performance. Unfortunately, the scientific finance literature does not support this expectation. The evidence indicates that superior past professional performance tends not to persist and is not a predictor of future performance. The most reasonable conclusion to reach is that relatively competitive and efficient financial markets are not reliably “beatable” on a long run, risk-adjusted basis.

The absurdity of the “positive alpha, superior mutual fund manager” assertion increases with the fees charged and the excess taxation resulting from over-active professional portfolio management. From the point-of-view of the individual investor, affordable alpha simply does not exist. Before costs and taxation, on average an investor can only expect to match the market return. Some will exceed the market return and some will fall short. However, it will tend to be luck rather than skill that will determine who wins and who loses. Once costs and taxation are factored in, the average investor will under-perform the market index.

The effort to find those few supposedly superior money managers willing to sell their services sufficiently cheaply is a costly, time consuming, and futile, “Where’s Waldo?,”* searching exercise for the individual investor.

Many money managers will claim to be superior and few or none actually will be. If such superior money managers did exist, then there should be dozens or hundreds of them who prove their superiority year after year after year. Unfortunately, the scientific finance literature indicates that this is not the case. This year’s star money manager tends to be next year’s average or laggard money manager.

Individual investors need to understand that proper evaluation of the potential skill of investment managers is not a trivial exercise. Institutions with assets to invest must select and monitor investment managers. They have fiduciary obligations to hire the best and the brightest of portfolio managers, who will in turn select and manage the actual investment portfolio. The scientific finance literature on investment manager selection is very extensive, goes back roughly four decades, and provides no easy, surefire answers.

For the individual investor, using something like a 4 star or 5 star rating to over-simplify the fund selection decision is no different than tossing darts to decide. (For some ideas on how individual investors might approach the investment fund selection decision more efficiently, see this category of articles on The Skilled Investor website: Selecting Investment Funds – Mutual Funds and ETFs. Also, see the articles in this category: Rating Services – Morningstar. )

* “Where’s Waldo” by Martin Handford is a series of illustrated children’s books. The objective is to locate Waldo wearing his little red cap within drawings that contain many many hundreds of other people. Finding Waldo is often challenging and time consuming. As opposed to searching for superior mutual fund managers, you actually can find Waldo with enough time.

Personal Financial Planning

Pay Lower Investment Expenses To Get Higher Investment Returns (
Pay Lower Investment Expenses To Get Higher Investment Returns - Part 1
Excessive investment costs are a plague on your personal financial planning.
Excessive investment expenses are one of the most significant barriers to lifelong family financial security. While financial services industry sales people tell you that you need to pay more to get more, the correct [...])

Efficient Market Pricing in the Investment Securities Markets (
Efficient market pricing is the theory that all known information is already reflected in current securities prices.
Efficient securities market pricing has become very widely accepted within the investment community. The preponderance of evidence is that securities markets are efficient and tend to reflect available information. Whether you believe markets are efficient is very important to [...])

How Investment Securities Are Valued – Snapshots in Time (
Snapshots in time - How investment securities are valued
Every securities market transaction requires a buyer and seller with differing viewpoints.
Markets can operate, because there are differences between investors in their assessments of the intrinsic value and risk of securities.
Current investment values vary in the eyes of the many beholders of investment market securities. Knowledgeable participants [...])

Diversify To Avoid Investment Fraud (Another kind of investment diversification that individual investors should consider important relates to the failure or corruption of the financial industry intermediaries and fiduciaries that hold individual investors’ securities.
This meaning of diversification has nothing to do with scientific investment principles related to optimal portfolio diversification. However, it is still very important. Prudent investment practices would [...])

Avoid High Turnover Mutual Funds and Active ETF Trading (Avoid investment funds with higher investment portfolio turnover
The problem with high turnover is that higher fund trading adds substantial hidden expenses that drag down returns.
Because short-term trading is a zero sum game (before costs) played against other well informed traders, greater turnover is far more likely on average to result in lower fund returns instead [...])

The Cost of Investment Counselors When You Pay Investment Sales Loads (How expensive is financial advisor compensation paid via sales loads?
A sales load might be the method that you prefer to compensate your broker or advisor. If your advisor is truly competent and ethical, he may be able to manage properly the inherent conflicts of interest that are associated with commissioned investment product sales. Even if [...])

Do Not Get Fooled by Superior Historical Investment Performance (
Evaluate the historical investment performance of mutual funds and ETFs, BUT ONLY AFTER using other screening criteria
Choosing only from among mutual funds and ETFs that have performed very well in the past can lead to significant selection mistakes and inferior personal portfolio returns
Previous superior or average fund performance simply does not predict similar fund performance [...])

Commodity Futures in Your Investment Portfolio (Commodity futures in your investment portfolio - Is there really any future for individual investors?
The Skilled Investor's previous article, "Be wary of the new investment asset classes," voiced skepticism about many supposedly new asset classes. This article delves into the financial science behind this skepticism, as it relates to one of these supposedly new asset [...])

Conclusion to: What Is a Well-Diversified Investment Portfolio? (<<-- Continued from Part 1
In addition to showing that large numbers of additional stocks are required to achieve measurable improvements in diversification, the Evans and Archer study clarified other requirements for a well-diversified portfolio. The number of stocks selected for a highly diversified portfolio also depends on what one actually means by "the market."
To achieve [...])

Avoid Very Large Actively Managed Mutual Funds (
Avoid very large actively managed mutual funds
Big actively managed mutual fund portfolio positions and higher percentage ownership of any company’s bonds or common stock are not good things for actively managed mutual funds. Nor, are these big positions and high percentages good for you.
Large portfolio size constrains how efficiently an actively managed mutual fund can [...])

Make More Optimal Tradeoffs Between Investment Risk and Return (VeriPlan helps you make more optimal decisions about the tradeoffs between investment risk, investment return, and personal savings
Too often decisions about risk-adjusted investing and asset allocation are over-simplified with a few questions about your risk tolerance. Typically, this superficial process will be followed quickly by the offer of a canned, off-the-shelf asset allocation scheme and [...])

Always Completely Diversify Your Investment Portfolio (Complete portfolio diversification is always a better idea.
On average, the securities markets will not pay you to hold any skewed subset of the overall market. Doing so is just a gamble that may or may not pay off. You should not expect to be paid any more for the added risk and anxiety.
A previous article, [...])

Investment Valuation and Securities Risk for Individual Investors (
The securities markets provide an evolving consensus of the risk-adjusted value of particular securities.
By understanding how the markets value securities, individual investors can chose more durable investment strategies
Judging the potential usefulness of different investment strategies requires some understanding of what the public securities markets really do. This article discusses how the markets price financial securities [...])

Your Investment Risk Tolerance Drives Your Asset Allocation Decision (
Your personal tolerance for investment risk should drive your asset allocation decision - A Tip from The Skilled Investor
Your tolerance for investment risk is a relative thing. Few people like investment risk, but some can handle it better than others do. The more investment risk you can and are willing to tolerate, the higher your [...])

Conclusion of the Biggest Personal Finance Story of the Past 30 Years ( < <-- Go to Part 4
The Biggest Personal Finance Story of the Past 30 Years - Conclusion
This article concludes our series on the greatest personal finance story of the past thirty years. In this article, we discuss whether the dramatic growth in equity value of the financial services sector indicates that securities markets are [...])

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